Emerging Markets: What needs to happen before we see a sustained recovery from the present global economic malaise and what’s your best guess on how long that will take?
Larry Summers: The dominant reason for economic weakness is lack of demand. The dominant reason for lack of demand is the consequences of deleveraging associated with the major loss of confidence that has taken place. It’s the central irony of financial crisis that while it’s caused by too much overconfidence, too much borrowing and lending and too much spending, it is only resolved through more confidence, more borrowing and lending and more spending. The appropriate emphasis today in almost every part of the world has to be on the promotion of growth. There’s a macroeconomic policy dimension to that in terms of both fiscal and monetary policy. There’s also a major structural dimension to it in terms of enhancing flexibility and in terms of increasing private sector confidence in part through necessary public investments. The details vary from country to country. It’s inevitable given the magnitude of the shocks that have been experienced that the resumption of growth will be slow, but the speed at which reasonable recovery is attained will depend upon the extent to which the problem is recognized as a deleveraging demand problem and addressed in those terms.
EM: Do you believe there’s anything approaching such a recognition today amongst policymakers globally?
LS: I think we are well short of the necessary recognition. Austerity in some circumstances may be necessary to avert catastrophe. It is never a growth strategy. It is a strategy – there have been times when fiscal consolidation can be a growth strategy, those have been times when interest rates have been very high and fiscal consolidation has permitted them to come down dramatically. At a moment like the present when interest rates are already very close to zero, there is never scope for austerity to be a growth strategy. It may be, and in some places is, a necessary defensive measure. Where it is a necessary defensive measure it needs to be complemented by other strategies to pursue growth focusing on the promotion of competitiveness to enhance exports, focused on the removal of barriers so as to promote business hiring and investment, focused on support for private consumption. Where it is not necessary to have rapid fiscal consolation it is necessary not to have fiscal consolidation so as to maintain an adequate level of demand. The risk we face is of a lost decade of potential economic growth in large parts of the world. The experience in Japan which today has a GDP one third to one half below the level that most would have expected in the 1990s is cautionary as the consequences of allowing cyclical problems to harden into structural problems.
EM: Are you hopeful, given what you’ve said, that any progress will be made towards zeroing in on demand led policies to drive growth globally?
LS: I’m always hopeful and certainly there have been some important positive steps such as the commitments that Mario Draghi has made in Europe, the emphasis that President Obama has placed on infrastructure investments and the IMF’s salutary move from an overwhelming focus on austerity and long run fiscal issues to a growing concern with hardened in stagnation.
EM: Given the excessive focus on austerity principally in Europe, how probable do you think this makes the potential break-up of the single currency area at this juncture?
LS: Ironically most observers think that the dominant issues for the single currency are political, and certainly there are important political issues for the single currency. I think important aspects of the issue though are economic. I think it’s become increasingly clear that there is overwhelming political will in Europe, including in Germany to maintain the single currency and to avoid what would really be the quite extraordinary risks associated with even the partial dissolution of the monetary union. There are though, two substantial risks. The first is of excessive risk taking as countries seek to pursue monetary [virtue] they overplay their hand and once the bank runs starts it’s impossible to put the situation back together again. The other substantial risk in the situation is that the political desires strain the system past the breaking point. There was no failure of political will to stay on gold in the 1930s, the problem was staying on gold was inconsistent with maintaining an adequate growth rate, and so eventually the political commitment to gold had to give way. Will that prove to be the case in Europe? That remains an important area of uncertainty. What’s clear is that the more emphasis there can be on a growth strategy for Europe which implicates the actions of both debtor and surplus countries, the greater prospect there will be of carrying on the profound political convictions to unity that exist in Europe.
EM: What’s your assessment of current plans for banking union in Europe and do you believe it’s possible for such a union to work without some form of debt mutualization?
LS: I think it remains to be seen. The aspiration is a worthy one. The devil will be in the details. The danger of course is that things will run behind schedule. I am very worried about the idea that it is possible to plan for the solution of future problems on a joint basis without recognizing that current problems, which one hopes and trusts will be the most important problems of the next quarter century are not treated on a joint and unified basis.
EM: Coming to the US economy, how worried should we be about the prospect of the so-called fiscal cliff?
LS: The last thing that the world economy needs right now is a major contractionary impulse coming from the United States. We have to desperately hope that we don’t get one. My judgment is that when all that is required is that a can be kicked, that even a lame duck session of Congress will be able to do that. But there are certainly no guarantees.
EM: What would be the implications if the economy were to fall off the fiscal cliff?
LS: Unemployment would rise, markets would fall, confidence would be lost, future output would be compromised and ironically, debt burdens would be increased.
EM: Even if Washington reaches an agreement to avoid the fiscal cliff, how vulnerable is the US nevertheless to fiscal turmoil next year?
LS: Ultimately the United States finances are not on a sustainable basis. We need to find a combination of growth promotion then fiscal adjustment that remedies those imbalances. If we don’t do that those who warn that there will eventually be consequences in bond markets are absolutely correct. So yes it is very important that we move to address our fiscal challenges and the sooner long term plans are put in place, the better, the more confidence there will be and the better off we will be with respect to all of our objectives.
EM: What should be the top economic priority for the next US administration?
LS: The restoration of growth and the re-attainment of the economy’s potential. The economy has been growing for some time. We have moved, we are no longer in a great recession, we are on the brink of a great stagnation if we are not able to enhance confidence and grow the economy more rapidly.
EM: Notwithstanding the present uncertainty do you think there is any more support now on Capitol Hill for tackling debt in a constructive manner or indeed for reaching some sort of grand bargain on public finances?
LS: I think it’s very difficult to know what the context will be after the election as we see subsequent movement, as we see what happens to the economy. In my experience the transition from inconceivable to inevitable can sometimes be surprisingly rapid in Washington.
EM: What would a recovery actually mean? Could we feasibly expect to see pre-crisis levels of growth?
LS: Remember that in principle we should be aspiring to more than pre-crisis levels of growth because we have the growth of potential plus we have the extra increment to growth that comes from returning to potential. I don’t expect it to happen in 2013 but it is not unreasonable to aspire to seeing growth rates of 5% or more for the world economy again. Just as there can be vicious cycles, there can be virtuous circles as well in which confidence promotes investment promotes growth promotes confidence promotes investment. In which growth promotes improved fiscal position which reduces capital costs, which promotes growth which produces improved fiscal conditions, in which stronger economies beget stronger financial systems which in turn support stronger economies. So the very same mechanisms of cumulative causation which were engaged to produce this downturn and its aftermath can be engaged to produce an upturn as well.
EM: But isn’t there a sense – especially in looking to the slowdown in the rest of the world, including the so-called BRICs economies – in which the growth drivers of the past decade are now somehow exhausted?
LS: I think there’s no question that the medium term prospects for the medium are more challenging that it has been at points in the past and the choices that nations make will be enormously consequential going forward but in my experience it is often darkest before the dawn and the fact that the mobile telephone on which I’m speaking to you which I find it hard to image living without, that by the end of this decade there will be five billion of them in the hands of people all over this planet points to opportunities that would have been unimaginable a decade ago. So yes there would have been growth drivers being lost but there are also growth drivers being found.